Balance of Payments, Developing-Country Debt, and The Macroeconomic Stabilization Controversy

Chapter 13
Balance of
Payments,
Developing-Country
Debt, and the
Macroeconomic
Stabilization
Controversy
Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

The Balance of Payments
• The current account: net flow of

merchandise trade
• The capital account: net flow of

financial capital
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Wesley. All rights reserved. 13-2
The current account:
• Exports (+)
• Imports (-)
• Investment income (+)
• Debt-service payments (-)
• Net remittances and transfers (+)
The capital account:
• Direct private investment (+)

• Foreign loans (+)
• Foreign assets of domestic banks (-)
• Resident capital outflow (-)

• The balance of payments position:

– Surplus: inflows > outflows
– Deficit: outflows > inflows
• Consequence:
– Surplus: increase in cash reserves account
– Deficit: decrease in cash reserves account
Payments Balances on Current
Account, 1980–2006 (billions of
dollars)

Consequences of BOP Deficit
• Reduce cash reserves account
• Inhabit imports: impose tariffs/quotas;

foreign exchange devaluation
• Increase exports: foreign exchange

devaluation
Consequences of BOP Deficit
• Impose restrictive fiscal and monetary policy
– Reduce income expansion to lower import growth

– Reduce inflation for exports to compete internationally
• Attract direct foreign investment
• Receive a greater share of the IMF’s “paper gold”

known as the Special Drawing Rights (SDRs)
• Increase external debt

Third World Debt Crisis
• The accumulation of external debt Since

early 1980s
• Allocation of a larger percentage of the GDP

(from export earnings) to service external
debt
• Scarcity of development funds: lack of

investment in physical, human, and social
capital© 2009 Pearson Addison-
Copyright
Dimensions of the LDC Debt
Burden, 1970–2008

Severely Indebted Countries
• Large outstanding debt
• Debt as a large percentage of GDP and

exports
• High debt service-to-GDP (or GNI) ratio
• Copyright
High debt service-to-exports
© 2009 Pearson Addison- ratio
External Debt Accumulation
Define Fn as the capital inflow (i.e., the

amount of debt accumulation)
Fn = dD
D = total external debt
d = percentage increase in total external
debt
External Debt Accumulation
• Define BT as the basic transfer and r as

average interest rate charged on external
debt
BT = dD – rD = (d - r)D
- dD: external debt

- rD: amortized debt
- d>r: debt accumulation
The Debt Crisis
• Rising d and d > r
• Switching from fixed, concessional rates to

short-term, variable rates
• BOP deficits as LDCs’ commodity prices

plummeted
The Debt Crisis
• Global recession, reducing demand for LDC

exports
• Lack of confidence in LDCs’ ability to repay

foreign loans
• Substantial amount of capital flight from the

LDCs
Petrodollars and Third World
Debt
The OPEC (i.e., Qatar, Saudi Arabia, Kuwait):

• Exports oil to LDCs and MDCs
• Deposits some of their export earnings in Western
banks
• Provides grants and interest-free loans to LDCs
Western Banks:
• Lend petrodollars to LDCs
• Receive
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debt Addison-
service payments from LDCs
The Mechanics of Petrodollar
Recycling

The IMF Stabilization Policy
• Remove foreign exchange and import controls
• Use a floating foreign exchange rate
• Adopt stringent anti-inflationary policy

– Increase interest rates
– Reduce budget deficits
– Control wage increases
– Eliminate price subsidies
• Invite foreign investment and improve economic

openness
Success in LDCs:
• Reduce inflation
• Improve balance of payments
• Eliminate parallel exchange rates
• Improve economic efficiency

Failure in LDCs:
• Double standards
– Harsh adjustments for the LDCs
– No adjustment for the MDCs
• Lending agencies
– Agents of international capitalism
– Increase LDC dependence and poverty
– Prefer short-term to long-term developmental loans
– Provide
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for corrupt LDC governments
Global Dimensions of LDC Debt
• Restructuring of short-term to long-term loans

• Debt forgiveness to selected LDCs if they
continue to use IMF stabilization policy
• Debt-for-equity swap: banks exchange loans for
ownership of domestic industries
• Debt-for-nature swap: MDC government forgive
loans if LDCs invest in preserving the
environment
Has the Debt Crisis Disappeared?
No! Debt crisis is just postponed!
• LDCs continue to borrow

• LDCs continue to make large debt service
payments
• In addition to the severely indebted LDCs,
countries in Africa are greatly dependent on
external debt


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Chapter 13

Copyright © 2009 Pearson Addison-Wesley. All rights reserved.

• The current account: net flow of

• The capital account: net flow of

Copyright © 2009 Pearson Addison-

The current account:

The capital account:

• Direct private investment (+)

Copyright © 2009 Pearson Addison-

• The balance of payments position:

Copyright © 2009 Pearson Addison-

• Reduce cash reserves account

• Inhabit imports: impose tariffs/quotas;

• Increase exports: foreign exchange

• Impose restrictive fiscal and monetary policy

– Reduce income expansion to lower import growth

• Attract direct foreign investment

• Receive a greater share of the IMF’s “paper gold”

• Increase external debt

• The accumulation of external debt Since

• Allocation of a larger percentage of the GDP

• Scarcity of development funds: lack of

Copyright © 2009 Pearson Addison-

• Large outstanding debt

• Debt as a large percentage of GDP and

• High debt service-to-GDP (or GNI) ratio

Define Fn as the capital inflow (i.e., the

• Define BT as the basic transfer and r as

- dD: external debt

• Rising d and d > r

• Switching from fixed, concessional rates to

• BOP deficits as LDCs’ commodity prices

• Global recession, reducing demand for LDC

• Lack of confidence in LDCs’ ability to repay

• Substantial amount of capital flight from the

The OPEC (i.e., Qatar, Saudi Arabia, Kuwait):

Copyright © 2009 Pearson Addison-

• Remove foreign exchange and import controls

• Use a floating foreign exchange rate

• Adopt stringent anti-inflationary policy

• Invite foreign investment and improve economic

Copyright © 2009 Pearson Addison-

• Restructuring of short-term to long-term loans

No! Debt crisis is just postponed!

• LDCs continue to borrow

Copyright © 2009 Pearson Addison-

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